Balance of Risks and the Anchoring of Consumer Expectations

Abstract

This paper shows that expected inflation risks pose threats to the anchoring of expectations. I propose a new method for fitting subjective probability distributions to density forecasts that allows for asymmetric beliefs over inflation outcomes. Using data from the Federal Reserve Bank of New York’s Survey of Consumer Expectations, I show that medium run expectations move in the direction of perceived short run risks. A diffusion index of consumers’ perceived balance of risks to inflation shows that high short run inflation expectations coincide with the balance of medium risks being weighted to the upside.